Making pension contributions can save you tax and at the same time the contributions go towards a retirement fund for your pension. The tax relief you receive is directly linked to your rate of income tax.
If you are a basic rate taxpayer, you will receive an extra 20% as tax relief on your eligible contributions.
If you are a higher rate taxpayer it’s 40%, and 45% if you are an additional rate taxpayer. There are slightly different rates in Scotland.
How does pension tax relief work?
Basic Rate Taxpayer
Let’s take a look at an example of a basic rate taxpayer. A basic rate taxpayer is anyone whose income is less than £50,270.
If you are a basic rate taxpayer and want to make a gross contribution of £100, you would pay £80, and receive a credit of £20 tax relief at source. This is because in making the payment of £80 you have already paid £20 (20%) in tax before you received the money. You therefore effectively pay in £80 and your pension provider will claim the £20 tax already paid from the government and this will be credited to your pension fund.
If you do not complete a tax return then this is automatically claimed for you by your pension provider. If you do file a tax return then you will need to make sure you enter your pension contributions on the tax return.
Higher Rate Taxpayer Saving 40%
A higher-rate taxpayer is anyone whose income is between £50,270 to £125,140. The tax rate is 40%.
As above, if you are a higher-rate taxpayer and wanted to make a gross contribution of £100, you would still pay £80, and receive a credit of £20 (20%) tax relief at source. You would then claim the further £20 (20%) by declaring the contribution on your tax return. You have therefore effectively paid only £60 with the other £40 given as tax relief.
This is because in making the payment of £80 you have already paid £40 (40%) in tax before you received the money.
Higher Rate Taxpayer Saving 60%
When your earnings exceed £100,000 you start to lose £1 of your personal tax allowance for every £2 of income over £100,000. If your income exceeds £125,140 then you no longer have any personal tax allowance left and the whole slice of that income of £25,140 above £100,000, has an effective tax rate of 60%. By making pension contributions you can effectively get tax relief at 60% for each £1 you pay that reduces your income below £125,140 to £100,000.
Additional Rate Taxpayer
An Additional rate taxpayer is anyone whose income is more than £125,140.
Once again, as above, if you are an Additional rate taxpayer and wanted to make a gross contribution of £100, you would still pay £80, and receive a credit of £20 (20%) tax relief at source. You would then claim the further £25 (25%) by declaring the contribution on your tax return. You have therefore effectively paid only £55 with the other £45 given as tax relief.
This is because in making the payment of £80 you have already paid £45 (45%) in tax before you received the money.
How Do You Actually Get The Tax Relief?
There are two ways in which tax relief is effectively provided. This will depend on how you make your pension contributions.
Net Pay Arrangements
If you have a workplace pension your employer will deduct your pension payments from your gross pay before any deduction of tax. In this way, you will receive the tax relief directly at source. Most workplace pensions now operate in this way. If you are not sure then you should ask your payroll department to confirm this. We can also check this for you if you can provide us with two consecutive payslips.
Relief at Source Arrangement
This is where you pay directly into your pension scheme and your pension provider claims the 20% tax relief on your behalf. The 20% tax relief claim is then added to your pension pot.
If you contribute to a personal pension this will be a relief at source pension, but some workplaces do still operate in this way too. As above it is therefore important that you know what your pension arrangement is otherwise you could miss out on the tax relief.
Claiming The Additional Pension Tax Relief – Higher Rate and Additional Rate taxpayers
If you are a higher rate or additional rate taxpayer you will need to complete a self-assessment tax return to claim the additional relief. As the tax return will also need you to declare all other sources of income, gains, and tax already paid making sure it is correct is important if you wish to avoid fines and penalties. At fixed fee tax return, we offer clear fixed fees to prepare and file your tax return. Get in touch for a no-obligation fixed fee quote.